Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding

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1 Citizens Research Council of Michigan Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding March 2015 Report 389 Celebrating 99 Years of Independent, Nonpartisan Public Policy Research in Michigan

2 Board of Directors Laura Appel Michigan Health & Hospital Association Michael G. Bickers PNC Financial Services Group Beth Chappell Detroit Economic Club Rick Cole Cole Creative LLC James Davlin General Motors. Retired Daniel Domenicucci Ernst & Young LLP Terence M. Donnelly Dickinson Wright PLLC Randall W. Eberts W. E. Upjohn Institute Sherrie L. Farrell Dykema Chair Terence M. Donnelly Eugene A. Gargaro, Jr. Manoogian Foundation John J. Gasparovic BorgWarner Inc. Ingrid A. Gregg Earhart Foundation June Summers Haas Honigman Miller Schwartz and Cohn LLP Marybeth S. Howe Wells Fargo Bank Gordon Krater Plante Moran Vice Chair Aleksandra A. Miziolek William J. Lawrence III Varnum 42 North Partners LLC Daniel T. Lis Attorney-At-Law Kristen McDonald The Skillman Foundation Michael P. McGee Miller, Canfield, Paddock and Stone PLC Treasurer Vacant Aleksandra A. Miziolek Cooper-Standard Automotive Inc. Paul R. Obermeyer Comerica Bank Kevin Prokop Rockbridge Growth Equity, LLC Jay Rising Detroit Medical Center Kelly Rossman-McKinney Truscott Rossman Candee Saferian PVS Chemicals, Inc. Christine Mason Soneral ITC Holdings Corp. Terence A. Thomas, Sr. Thomas Group Consulting, Inc. Theodore J. Vogel CMS Energy Corporation Larry Yachcik Porter Hills Board of Trustees Terence E. Adderley Kelly Services, Inc. Jeffrey D. Bergeron Ernst & Young LLP Stephanie W. Bergeron Walsh College Beth Chappell Detroit Economic Club Richard T. Cole Cole Creative LLC Brian M. Connolly Oakwood Healthcare, Inc. Matthew P. Cullen Rock Ventures LLC Stephen R. D Arcy Detroit Medical Center Richard DeVore PNC Bank Terence M. Donnelly Dickinson Wright PLLC John M. Dunn Western Michigan University David O. Egner Hudson-Webber Foundation New Economy Initiative David L. Eisler Ferris State University David G. Frey Frey Foundation Mark T. Gaffney Eugene A. Gargaro, Jr. Manoogian Foundation Ralph J. Gerson Guardian Industries Corporation Eric R. Gilbertson Saginaw Valley State University Allan D. Gilmour Wayne State University, Emeritus Alfred R. Glancy III Unico Investment Group LLC Thomas J. Haas Grand Valley State University David S. Haynes Northern Michigan University James S. Hilboldt The Connable Office, Inc. Paul C. Hillegonds DTE Energy Company. Retired Daniel J. Kelly Deloitte. Retired David B. Kennedy Earhart Foundation Mary Kramer Crain Communications, Inc. Chair Eugene A. Gargaro, Jr. Gordon Krater Plante & Moran PLLC David Leitch Ford Motor Company Edward C. Levy, Jr. Edw. C. Levy Co. Daniel Little University of Michigan-Dearborn Alphonse S. Lucarelli Ernst & Young LLP. Retired Sarah L. McClelland JPMorgan Chase & Co. Anne Mervenne Mervenne & Co. Aleksandra A. Miziolek Cooper-Standard Automotive Inc. Glenn D. Mroz Michigan Technological University Mark A. Murray Meijer Inc. James M. Nicholson PVS Chemicals Don R. Parfet Apjohn Group LLC Philip H. Power The Center for Michigan Keith A. Pretty Northwood University John Rakolta Jr. Walbridge Douglas B. Roberts IPPSR- Michigan State University Milton W. Rohwer George E. Ross Central Michigan University Gary D. Russi Nancy M. Schlichting Henry Ford Health System John M. Schreuder First National Bank of Michigan Amanda Van Dusen Miller, Canfield, Paddock and Stone PLC Kent J. Vana Varnum Theodore J. Vogel CMS Energy Corporation Gail L. Warden Henry Ford Health System, Emeritus Jeffrey K. Willemain Deloitte. Retired is a tax deductible 501(c)(3) organization

3 Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding March 2015 Report 389 This full analysis of Proposal was amended slightly on March 23, In the first full paragraph of the second column on page 15 of the report, the original report stated that... the act also phases in across a three year period a 36.1 percent increase in registration taxes on large trucks weighing over 26,000 pounds. In fact the increases vary depending on the gross vehicle weight of the truck. As noted later in the paragraph, a common 5-axle interstate tractor-trailer registered with an 80,000 pound gross vehicle weight will be subject to a 36.1 percent increase in registration taxes. We have replaced the underlined words in the sentence in question with an increase and noted that the increases will vary by gross vehicle weight. CITIZENS RESEARCH COUNCIL OF MICHIGAN Eric W. Lupher, President MAIN OFFICE Six Mile Road, Suite 208 Livonia, MI Fax LANSING OFFICE 115 West Allegan, Suite 480 Lansing, MI CRCMICH.ORG

4 Do you find this report useful? The is a non-profit organization that can only provide information to policy makers and citizens with support from people like you. You can learn more about the organization at If you found the contents of this report useful and wish to provide financial support to help carry on CRC s mission, please fill out the form below and send it to: Six Mile Road, Suite 208 Livonia, MI YES! I want to help in the support of sound public policy in Michigan! NAME ADDRESS / PHONE I wish to make a one-time, tax-deductible gift of: $ I wish to pledge a total of $ with an initial payment of $. I would like my contribution to support: Annual Fund Endowment Please mark my gift: Anonymous In Honor Of: In Memory Of: Gift will be matched by: Or donate online at

5 Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding Contents Summary...iii Introduction...1 Background: Financing Michigan s Transportation Infrastructure...2 Proposed Constitutional Amendment...5 Sales Tax... 5 One Tax, Two Rates... 5 History of the Sales Tax Rate... 7 Interstate Comparison... 7 Exempting Motor Fuels from the Sales Tax... 7 Taxing Motor Fuels... 7 Constitutional Exemption... 8 Other Fuels not Exempt... 8 Sales and Use Tax Revenue Earmarks... 9 Local Governments... 9 School Aid Fund... 9 School Aid Fund Higher Education Appropriations Permissible Uses of the School Aid Fund Ballot Proposal Linkages: Items Tied to the Vote...11 Sales and Use Tax Increases Motor Fuel Tax Increase Adjustment of Future Motor Fuel Tax Rates Interstate Comparison of Motor Fuel Taxes Alternative Fuels Vehicle Registration Taxes Road Construction Process: Bidding, Warranties, and Road Design Tax Credits for Low- and Moderate-Income Households Analysis of Proposal The Proposal s Fiscal Implications on the Public Sector Impact on Taxes Paid at the Pump The May 5 Vote: Key Issues for Voters...21 Appendix A:...22 Appendix B:...23 i

6 CRC Report Tables Table 1 Impact of Registration Tax Changes Table 2 Potential Impact of Increase in State Earned Income Tax Credit Table 3 Estimated Impact of Ballot Proposal on Revenue and Spending Table 4 Initial Impact of Tax Changes at the Pump Charts Chart 1 Revenue from Major Transportation Taxes: FY1997-FY Chart 2 Percent of State Trunkline Roads with Good, Fair, and Poor Pavement Conditions... 3 Chart 3 Percent of Federal Aid Non-Trunkline Roads with Good, Fair, and Poor Pavement Conditions... 3 Chart 4 School Aid Fund Appropriations for Higher Education: FY2010-FY Chart 5 Looking Back: Historical Gas Tax Rates Under the Proposed Rate Adjustment Mechanism ii

7 Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding On May 5, 2015, Michigan voters will be asked to vote on a single statewide ballot measure to amend the state Constitution: Proposal Approval of Proposal 15-1 will result in increases in various state taxes, expansion of state tax credits, additional state funds for road repair and maintenance, and additional state funds for public schools and local governments. Of some confusion, perhaps, is that voters are only being asked to directly approve some of these changes; those amending the Constitution. The bulk of the other state tax changes are contained in laws passed last legislative session that would only take effect if Proposal 15-1 is approved. At the end of the legislative session, the governor and legislative leaders agreed to a complex plan to address the dual objective of increasing state funding for road repair and maintenance and modifying the taxation of motor fuels to guarantee that all taxes paid at the pump were directed to transportation purposes. Additionally, the plan seeks to ensure that other recipients of state funds are not financially harmed in the pursuit of these two Summary primary goals. By necessity, the plan consists of both constitutional and statutory components. While the statutory law changes require only legislative and gubernatorial approval, the constitutional changes require approval by the Michigan electorate. However, because the law changes are tie-barred to passage of Proposal 15-1, the public vote effectively serves as a referendum on the entire transportation funding package, both the constitutional and statutory changes. Voters are being asked to directly approve changes to the Constitution and indirectly approve changes in various state laws to implement the complex transportation funding plan. If voters approve Proposal 15-1, the state Constitution will be amended and various state laws will take effect to increase state tax revenue by nearly $2.1 billion next fiscal year and by $1.8 billion annually in the following two fiscal years. If voters reject Proposal 15-1, there will be no changes to the Constitution and none of the proposed tax changes contained in the state laws linked to the proposal will take effect. Changes Impacting Road Funding and Transportation Proposal 15-1 and the various laws tie-barred to the proposal can be divided into three main issues or categories of change. First, the proposal modifies the taxation of gasoline and diesel fuel. This is accomplished by exempting these fuels from the sales tax base and changing how the state per-gallon motor fuel tax is calculated. The combination of these tax changes will likely increase the overall taxes paid at the pump. In combination, these changes are expected to bring in $1.3 billion per year in additional revenue for road repair and maintenance and other transportation purposes. This would be accomplished through statutory and constitutional changes that: (Changes to the constitution, which require voter approval and are included in Proposal 15-1, are emphasized in blue) 1. Exempt gasoline and diesel fuel used to power vehicles on public roads from the sales and use tax; 2. Increase the state s motor fuel tax rates (currently 19 cents per gallon for gasoline and 15 cents per gallon for diesel fuel) to equal 14.9 percent of the recent wholesale price of each fuel. Initial per-gallon rates would be 41.7 cents for gasoline and 46.4 cents for diesel motor fuel; 3. Establish a floor and ceiling for motor fuel tax rates that allow for annual inflationary increases to the rates and limit the volatility of future rate changes in response to future swings in wholesale fuel prices; and iii

8 CRC Report 4. Increase vehicle registration revenues by eliminating the depreciation discount currently given to passenger vehicles in the first few years; increase registration taxes on large trucks; and establishing a new registration tax surcharge for electric vehicles. Changes to Restore Funding from Sales Tax Exemptions The transportation funding package proposes to eliminate fuel from the base of the sales tax. Portions of the revenues from the sales tax flow into the state s General Fund and others are dedicated to the School Aid Fund and state revenue sharing to local governments. As a result, there would be less state funding available to these programs. The second major category of change associated with Proposal 15-1 and the linked state laws deal with modifications to the sales and use tax rates and how revenue from these taxes is distributed to hold these programs harmless. Because the state Constitution limits the maximum sales tax rate that can be levied, changes involving the tax rate require voter approval. Overall, changes to the sales and use taxes are expected to generate an additional $795 million per year for public schools, local governments, and the General Fund. These changes propose to: 5. Increase the maximum authorized rate of the sales tax from 6 percent to 7 percent; 6. Increase the use tax rate from 6 percent to 7 percent; 7. Dedicate 15 percent of the sales tax revenue collected at a rate of up to 5 percent (currently 4 percent) for per-capita allocations to cities, villages, and townships; 8. Dedicate 60 percent of the sales tax revenue collected at a rate of up to 5 percent (currently 4 percent) to the School Aid Fund; and 9. Dedicate 12.3 percent of the use tax revenue collected at a rate of up to 5 percent to the School Aid Fund (currently no portion of the tax levied at 4 percent is dedicated to the School Aid Fund). Changes to Ensure Accountability of New Funding and Help those Most Impacted by Tax Increases Finally, a number of other legislative and constitutional changes are included to address concerns regarding collateral impacts caused by tax increases and changes to revenue distributions. These proposed changes would: 10. Modify the allowable uses of the School Aid Fund to exclude higher education and include public community colleges, career and technical education programs, and certain community college or career and technical education program scholarships; 11. Introduce new road construction and maintenance bidding, warranty, and road design guidelines to help ensure that new road funding is spent efficiently; 12. Increase the state s Earned Income Tax Credit (EITC) for low-income tax filers in an effort to help offset the regressive nature of the tax increases; and 13. Expand the state s Homestead Property Tax Credit for very low-income senior citizens and disabled homeowners in an effort to help offset the regressive nature of the tax increases. iv

9 Proposal 15-1: Sales and Motor Fuel Tax Increases Related to Transportation Funding Impact on the Public Sector CRC estimates that Proposal 15-1 will increase sales and use tax revenues by $795 million in Fiscal Year 2016 (FY2016), with slightly less revenue collected in FY2017 and FY2018. The revenue increase will mean additional funding for the School Aid Fund, revenue sharing to local governments, some public transit programs, and the state s General Fund. Net revenue gains from motor fuel tax changes designed to increase road and transportation funding are estimated to be around $1.3 billion in FY2016, with marginally more revenue raised in FY2017 and FY2018. For the first two years, $860 million and $460 million, respectively, of the additional revenue is dedicated by law to pay down past state transportation borrowing and the remaining funds will be allocated to state and local road agencies and public transit programs through the transportation distribution formula. Initial indications are that these new revenues are viewed by state policymakers as easing pressures on the state s General Fund by allowing funds currently appropriated for transportation improvements to be redirected to other purposes. Currently, $285 million from the state General Fund is being used to subsidize dedicated transportation funding and allow for additional road repair and maintenance. If Proposal 15-1 is approved, a portion of the $1.3 billion revenue gain will be used to supplant the General Fund resources going to road repair, thus easing pressures on the General Fund budget and reducing the net gain in road funding. Impact on Michigan Citizens How Proposal 15-1 and related legislation impact the amount motorists pay at the pump will depend on the price of fuel. At current prices (roughly $2.40 per gallon in March 2015), constitutional and legislative changes would result in a 10.2 cent increase in the per-gallon price of gasoline with the tax rates to be levied in FY2016. Perhaps counterintuitively, as the price of gasoline increases the difference between what consumers pay under the current system and what they would pay under the proposed system shrinks. For example, if per-gallon gasoline prices rise to $3.85 during FY2016, consumers will only pay 2.1 cents per gallon more under Proposal 15-1 (See Table A). Michigan s citizens will also be obliged to pay a seven percent sales tax on goods subject to the tax; a one percentage point increase from the current rate of six percent. The impact of this will vary by individual but sales taxes tend to have a greater cost impact on lower-income individuals and families who spend proportionally more of their income on taxed goods than higher-income individuals and families. Therefore, the proposal includes an increase in the state s Earned Income Tax Credit as well as the Homestead Property Tax Credit for very low-income seniors and disabled homeowners. Table A Initial Impact of Tax Changes at the Pump Per-Gallon Cost Pre-Tax Retail Price $1.90 $2.50 $3.25 Current Proposal Current Proposal Current Proposal Federal gasoline tax $0.184 $0.184 $0.184 $0.184 $0.184 $0.184 State sales tax $0.125 $0.000 $0.161 $0.000 $0.206 $0.000 State gasoline tax $0.190 $0.417 $0.190 $0.417 $0.190 $0.417 Tax Subtotal $0.499 $0.601 $0.535 $0.601 $0.580 $0.601 Final Pump Price $2.399 $2.501 $3.035 $3.101 $3.830 $ cent increase 6.6 cent increase 2.1 cent increase v

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11 Statewide Ballot Issue: Proposal 15-1 Sales and Motor Fuel Tax Increases Related to Transportation Funding Introduction Increasing state funding for transportation infrastructure improvements has been a public policy issue in Michigan for a number of years. Despite broad support from a diverse coalition of groups across the state, including many in the business community, local government, and labor organizations, a comprehensive legislative solution has proved elusive. That is, until the waning days of the legislative session when Governor Snyder and legislative leaders agreed to the dual goal of increasing funding for roads and simplifying the taxation of motor fuel so that revenues from all motor fuel taxes would be dedicated to transportation improvements. This required development of a complex plan to restructure various state taxes. At the center of this transportation funding package and key to its enactment is a constitutional amendment that increases the maximum authorized sales tax rate from 6 percent to 7 percent, which can only be done by a vote of the people. The increase in the tax rate will not directly increase the amount of money for transportation purposes; instead it is being sought to address the funding displacement that would be caused by exempting motor fuels from the sales tax base, which is part of the constitutional amendment. The proceeds from the sales tax increase would be used to offset the funding reductions to schools and local governments that would occur from the new sales tax exemptions; these entities are the primary benefactors of sales tax receipts. The laws enacted in December 2014 as part of the transportation funding package will not take effect unless voters approve Proposal 15-1 at the special election on May 5. The fact that these laws, including those raising taxes and fees, are tie-barred to the statewide vote means that the May vote effectively serves as a referendum on the entire transportation funding package, both the constitutional and statutory components. If voters reject Proposal 15-1, there will be no change in the state tax landscape. This all or nothing proposition also means that there is no backup plan to address the transportation funding challenge should voters not approve Proposal THE FOLLOWING STATEWIDE BALLOT PROPOSAL WILL APPEAR ON THE MAY 5, 2015 SPECIAL ELECTION BALLOT PROPOSAL 15-1 A proposal to amend the State Constitution to increase the sales/use tax from 6% to 7% to replace and supplement reduced revenue to the School Aid Fund and local units of government caused by the elimination of the sales/use tax on gasoline and diesel fuel for vehicles operating on public roads, and to give effect to laws that provide additional money for roads and other transportation purposes by increasing the gas tax and vehicle registration fees. The proposed constitutional amendment would: Eliminate sales / use taxes on gasoline / diesel fuel for vehicles on public roads. Increase portion of use tax dedicated to School Aid Fund (SAF). Expand use of SAF to community colleges and career / technical education, and prohibit use for 4-year colleges / universities. Give effect to laws, including those that: Increase sales / use tax to 7%, as authorized by constitutional amendment. Increase gasoline / diesel fuel tax and adjust annually for inflation, increase vehicle registration fees, and dedicate revenue for roads and other transportation purposes. Expand competitive bidding and warranties for road projects. Increase earned income tax credit. Should this proposal be adopted? 1

12 CRC Report Background: Financing Michigan s Transportation Infrastructure Funding for Michigan s state and local roads primarily originates from state taxes that are distributed through a statutory formula to the Michigan Department of Transportation, Michigan s 83 counties, and to state s cities and villages to care for the roads. Michigan leans heavily on two sources of state revenue to finance the maintenance of its road infrastructure: motor fuel taxes and vehicle registration taxes. However, as illustrated in Chart 1, revenues from these sources have been largely flat since the last increase in the gasoline tax was enacted in The key issue contributing to the declining revenues is that Michigan s motor fuel taxes are set at a fixed per-gallon rate (19 cents per gallon for gasoline and 15 cents per gallon for diesel fuel). However, on average, motorists have purchased fewer gallons of fuel each year for two reasons. First, automobile fuel efficiency has improved in recent years, meaning that drivers need less gasoline to get to any given destination. The U.S. Energy Information Administration reports that the average fuel economy of new light-duty vehicles rose from 27.1 miles per gallon in 2008 to 32.7 miles per gallon in 2012, with further increases projected through the next decade. 1 Second, motorists are driving less than in the past. In 2005, motorists drove over 104 billion miles on Michigan roadways according to Federal Highway Administration data. By 2012, that figure had dropped to 94.5 billion miles a decline of over 9 percent. 2 The result: Motor fuel tax revenues have declined over time, offsetting any gains in revenue from registration taxes. Revenues from both sources in FY2014 were actually lower in nominal dollars than they were 12 years earlier in FY U.S. Energy Information Administration, Annual Energy Outlook 2014, Figure MT U.S. Department of Transportation, Federal Highway Administration, Highway Statistics Series. Chart 1 Revenue from Major Transportation Taxes: FY FY2014 (in billions) $2.5 $2.0 $1.7 $1.8 $1.9 $1.9 $2.0 $2.0 $2.1 $2.0 $2.0 $1.9 $1.9 $1.8 $1.8 $1.8 $1.9 $1.9 $1.9 $1.5 $1.5 $1.0 $0.5 $0.0 FY2014 FY2013 FY2012 FY2011 FY2010 FY2009 FY2008 FY2007 FY2006 FY2005 FY2004 FY2003 FY2002 FY2001 FY2000 FY1999 FY1998 FY1997 Motor Fuel Taxes Vehicle Registration Taxes Source: Michigan House Fiscal Agency 2

13 Proposal 15-1: Sales and Motor Fuel Tax Increases Related to Transportation Funding During the same time, the costs of maintaining and repairing the state s road system have risen. A commonly cited measure of road construction costs is the National Highway Construction Cost Index. 3 Between March 2003 (when the index was first established) and September 2014, the index suggests construction costs nationally have risen by about 13.5 percent. 4 With stagnant revenues unable to keep up with the increasing needs and costs of road maintenance, road quality has deteriorated. Chart 2 and Chart 3 highlight trends in the percentage of state trunkline (interstate and state M-route and US-route highways) and non-trunkline (other federal aid-eligible non-highway roads) roadways classified as being in good, fair, and poor condition according to data from the Michigan Transportation Asset Management Council. The charts show that road conditions have deteriorated within both road classifications. The percentage of state trunkline lane miles in good condition (brown segment of Chart 2) fell from 35 percent in 2007 to 25 percent in 2013, while lane miles in poor condition (blue lined segment of Chart 2) rose from 10 percent to 15 percent over the same period. Conditions worsened to an even greater extent for the nontrunkline roadways with the percentage of lane miles in poor condition (brown segment of Chart 3) rising from around 15 percent in 2005 to just over 43 percent by Chart 2 Percent of State Trunkline Roads with Good, Fair, and Poor Pavement Conditions Percentage of Lane Miles 100% 80% 60% 40% 20% 0% Good Fair Poor Chart 3 Percent of Federal Aid Non-Trunkline Roads with Good, Fair, and Poor Pavement Conditions Percentage of Lane Miles 100% 80% 60% 40% 20% 0% Good Fair Poor Source: Michigan Transportation Asset Management Council, Pavement Condition and Forecasting Dashboard, MITRP/Data/PaserDashboard.aspx In a larger sense, the ballot proposal is essentially a referendum on a larger package of legislation aimed at addressing the state s transportation infrastructure needs. 3 Data from the index is available at 4 The index shows national construction costs actually peaked in September 2006 and September 2008, reaching levels that were 35 to 40 percent higher than in the March 2003 base period. However, the impact of the Great Recession pushed costs down significantly between the end of 2008 and the beginning of

14 CRC Report The Need for a Public Vote State lawmakers encountered a policy issue somewhat unique to Michigan in attempting to craft a solution to the state s chronically deteriorating roads. As public attention about the condition of the roads increased and consensus formed around the need to increase transportation spending, many voiced a policy preference that all taxes levied on motor fuels should be used exclusively for road care. Michigan is one of a few states that levy a sales tax on motor fuels. Sales tax revenues do not go towards roads, but portions of the revenues are primarily dedicated to schools and local governments through the constitution. The public policy response to address the poor road conditions involves the dual objective of garnering more funding for roads and simplifying the tax structure so that only motor fuel excise taxes are levied on motor fuels. In developing the plan, policymakers were confronted with the fact that simplifying the tax structure by exempting motor fuels from the sales tax would financially harm schools and local governments unless there was offsetting action to increase funding to these programs another way. In most other states, actions to keep schools and local governments whole through such a tax simplification effort would not require a vote of the people. It is only because the Michigan Constitution limits the sales tax rate and dedicates funding from the sales tax to these specific purposes that a constitutional amendment is necessary to achieve this end. While a vote of the people is required to amend the state constitution in almost every other state, few other states have included such prescriptive provisions in their constitutions. All states set tax rates statutorily. If other states do dedicate revenues to specific purposes, most include such detailed material more appropriately within state laws. An ideal situation would have the state levy taxes needed to fund the services and functions necessary for the operation of state government and the ancillary programs. State policymakers would then prioritize the services with the greatest needs and direct available funding to meet those needs. However, the citizens of Michigan have moved away from the ideal situation by creating a number of constitutional limits on the policy actions of their elected officials, most notably by: Limiting the sales tax rate that may be levied by the state and excluding local governments from levying local-option sales taxes; Dedicating revenues from specific taxes and other sources to favored purposes; and Limiting the rate of taxation that may be applied to property. The has long admonished the drafters of constitutional amendments who placed these provisions into the Constitution. Such provisions go beyond serving their immediate purposes and often hamstring elected officials down the road from responding to changing circumstances. As a result, any subsequent revisions to these provisions that might become necessary involve the cumbersome and expensive steps of requesting voter approval for constitutional amendments. Proposal 15-1 is an example of these onerous public policies coming to fruition. More than one commentator has chided the legislature for passing responsibility for crafting a solution for Michigan s road funding problems on to the voters. Given the limitations Michigan residents have placed in the state Constitution over the years, achieving the dual goals of increasing transportation funding and simplifying the tax structure on motor fuels could not be achieved without involving the voters. In short, this is a problem of our own creation largely caused by the nature of the material we have chosen to populate our fundamental governing document. Unfortunately, the proposed solution does not fix the problem for future policymakers. Instead, the solution makes it worse by adding another restriction to the Constitution that exempts motor fuel from the sales tax and expands the earmarking of sales and use tax receipts. This could require Michigan voters to repeat this process in the future. 4

15 Proposal 15-1: Sales and Motor Fuel Tax Increases Related to Transportation Funding Proposed Constitutional Amendment Proposal 15-1 is a proposed constitutional amendment that was placed on the ballot by the Michigan Legislature and will be submitted to voters at a special election on May 5, If approved by the voters, the proposal will substantively amend three sections (Sections 8, 10, and 11) of Article IX (Finance and Taxation) of the 1963 Michigan Constitution. As a constitutional amendment, the proposal must be distinguished from the various laws adopted by the legislature associated with the complex transportation funding package. These laws are described later in the paper. The constitutional amendment, if approved, will: Increase the maximum rate of the sales tax from 6 percent to 7 percent; Exempt gasoline and diesel fuel used to power vehicles on public roads from sales and use taxes; Dedicate 15 percent of the sales tax revenue collected at a rate of up to 5 percent (currently 4 percent) for assistance to townships, cities, and villages; Dedicate 60 percent of the sales tax revenue collected at a rate of up to 5 percent (currently 4 percent) to the School Aid Fund; Dedicate 12.3 percent of the use tax revenue collected at a rate of up to 5 percent to the School Aid Fund (currently none of the tax at the 4 percent rate is dedicated to the School Aid Fund); and Modify the allowable uses of the School Aid Fund to exclude higher education and include public community colleges, career and technical education programs, and certain community college or career and technical education program scholarships. Sales Tax Michigan has levied a state sales tax since 1933, initially at a rate of 3 percent. The tax rate was increased to 4 percent in 1961 and to 6 percent in The tax is levied on retailers based on their gross sales (i.e., the retail price) of tangible personal property. Article IX, Section 8 of the Michigan Constitution caps the maximum sales tax rate that the legislature can impose at a rate of 6 percent. Currently, the legislature has authorized the tax to be levied at the maximum 6 percent rate. One Tax, Two Rates For consumers paying the sales tax, the tax appears as a single tax levied at a 6 percent rate. However, the current 6 percent rate has two distinct parts; a 4 percent rate and a 2 percent rate. Each component has its own language in the Michigan Constitution and the revenues generated by each are allocated differently. Proposal 15-1 would modify the language dealing with the 4 percent rate; the 2 percent rate language is unaffected. The current 4 percent rate is established within the constitutional limitation found in Article IX, Section 8, which states... the Legislature shall not impose a sales tax on retailers at a rate of more than 4%... This provision grants the legislature the power to levy a tax at a rate of up to 4 percent, but it does not require the legislature to do so. Section 8 was amended in 1994 to require that an additional 2 percent tax rate be imposed. Unlike the permissive language pertaining to the 4 percent tax rate limit, the 2 percent tax rate is mandated. Because the Constitution states that the additional 2 percent rate shall be imposed, the 2 percent rate is the minimum that the legislature must levy. Thus, the legislature can authorize a sales tax rate ranging from 2 percent to 6 percent. The General Sales Tax Act (Public Act 167 of 1933) currently sets the tax rate at the 6 percent maximum. Proposal 15-1 allows the legislature to increase the 4 percent rate up to 5 percent. The proposed change, combined with the required 2 percent rate, has the effect of increasing the maximum total sales tax rate that the legislature can impose from the current 6 5

16 CRC Report Giving Effect to State Laws via a Constitutional Amendment Proposal 15-1 is rather unique as a ballot measure in that it directly asks voters to approve a constitutional amendment, but that direct vote also indirectly triggers the enactment of an entire package of laws. While each law embraces an appropriate subject, passed the legislature with the necessary support, and was signed by the governor, it is unclear whether the public vote triggering mechanism passes muster with the state Constitution. The laws necessary to increase motor fuel taxes are not part of the constitutional amendment voters are being asked to approve at the May election. However, in order for those laws to take effect, voters must approve Proposal This is because each of the laws is tie-barred to the public vote. A tie bar is a device to condition the effectiveness of legislation on the enactment or passage of other specified legislation. Michigan s Constitution is clear that the legislative power of the state is vested in a senate and a house of representatives (Article IV, Section 1). Being so vested, the legislature is without power to delegate any part of it, except as authorized to do so by the constitution. In two provisions of the 1963 Constitution the people have retained direct roles in the lawmaking process. Both require gaining the approval of a majority of voters at a statewide election. The statutory initiative is defined by Article II, Section 9 as the power which the people reserve to themselves to propose laws and to enact and reject laws. The power of initiative extends to the people the power to enact any law that the legislature may enact and is invoked by filing petitions. The legislature is required to enact, without modification, or reject any laws proposed by initiative within 40 session days. An initiative not enacted by the legislature is placed on the statewide ballot at the next general election. A total of 13 statutory initiatives have appeared on the ballot since the adoption of the current constitution; seven initiatives were approved and six proposals were rejected. Article IV, Section 34 allows any bill approved by the legislature and signed by the governor (except bills appropriating money) to provide that it will not become law unless approved by the voters. This is called a legislative referendum. Since 1963, voters have faced 13 legislative referenda; they approved nine and rejected four. The laws that are tie-barred to Proposal 15-1 are neither statutory initiatives (i.e., filed by petition) nor legislative referenda (i.e., directly referred to the voters for approval by the legislature), although they are functioning much like the latter. However, instead of voters being asked to approve each individual law separately at the May election, they are being asked to approve the entire package of legislation en masse. The vote on the constitutional amendment effectively serves as a referendum on the entire complex package of laws. Giving effect to a single law, let alone a host of laws, via a public vote on a constitutional amendment is not a common occurrence. In fact, the only other instance when this occurred was under Proposal A of While the legislature frequently uses the tie-bar mechanism to condition the effectiveness of legislation on the approval of other specified legislation, Proposal 15-1 uses this tool to link the enactment of a number of laws to a constitutional amendment proposed by the legislature. In this sense, it does not meet the requirements of either a statutory initiative or a legislative referendum. From a constitutional perspective, it calls into question whether Proposal 15-1 represents a proper delegation of legislative powers. 6

17 Proposal 15-1: Sales and Motor Fuel Tax Increases Related to Transportation Funding percent to 7 percent. The constitutional language that voters are being asked to approve is permissive, not mandatory. While the Constitution sets out limitations on the sales tax rate, the actual rate itself is established through state law. To effect an increase in the tax rate, the legislature needed to enact amendments to the General Sales Tax Act, which it did with the package of laws tie-barred to Proposal 15-1 (discussed below). History of the Sales Tax Rate Although the state sales tax was first levied in 1933, a rate ceiling was not established until 20 years later. In 1954, voters approved the first constitutional sales tax rate limitation (3 percent). As is the case today, the language added to the Constitution was permissive, stating At no time shall the legislature levy a sales tax of more than three percent. Again, in 1960, voters approved an increase in the rate ceiling from 3 percent to 4 percent. Since 1960, there have been five attempts to increase the maximum sales tax rate four unsuccessful and one successful. In 1980, 1981, and twice in 1989, voters rejected proposals to increase the sales tax from 4 percent to 5.5 percent, 5.5 percent, 6 percent and 4.5 percent, respectively. In each instance, the proposed sales tax rate increase was part of a larger plan designed to provide taxpayers with some degree of property tax relief. In addition to lowering the property tax burden, both proposed rate increases in 1989 involved efforts to reform the state s K-12 education finance system. Property taxes played a key role in financing education and the sales tax increases were pursued as a way to hold schools harmless from the tax reductions. Following the four unsuccessful attempts, voters approved an increase in the rate ceiling by two percentage points in Similar to the previous attempts to increase the sales tax rate, this amendment was part of a larger fiscal plan to reduce local property taxes and reform the financing of public schools. However, unlike the previous endeavors, Proposal A The constitutional language that voters are being asked to approve is permissive, not mandatory. While the Constitution sets out limitations on the sales tax rate, the actual rate itself is established through state law. did not allow voters to maintain the status quo taxing scheme. Instead, they were forced to choose between the sales tax rate increase that was part of Proposal A and a personal income tax rate increase that was enacted in state law as a plan B in providing a trade-off for the property tax relief. Voters chose an increase in the sales tax over an increase in the personal income tax. Interstate Comparison. Forty-five states and the District of Columbia levy state sales taxes. Many of these states also allow local-option sales taxes, which increase the overall sales tax burden in some locations within these states. The Michigan Attorney General has ruled that local sales taxes are not permitted under the Michigan Constitution. 5 Of the states levying statewide sales taxes, the highest rate is 7.5 percent in California with five states tied for the second highest at 7 percent. 6 The state with the lowest rate is Colorado at 2.9 percent. A total of 10 states (including Michigan) have a 6 percent sales tax rate. Michigan s neighbors levy their sales taxes at various levels: 5 percent (Wisconsin), 5.75 percent (Ohio), 6.25 percent (Illinois), and 7 percent (Indiana). At 6 percent, Michigan is tied for the 16 th highest rate nationally. If approved, Proposal 15-1 would move Michigan to a tie for the second highest state levied sales tax rate in the nation at 7 percent. (See Appendix A.) Exempting Motor Fuels from the Sales Tax Taxing Motor Fuels. The State of Michigan levies several different taxes on the sale of motor fuels (e.g., gasoline and diesel). Currently, gasoline sold in Michigan is taxed at 19 cents per gallon and diesel fuel is taxed at 15 cents per gallon. In addition to these fixed per-gallon excise taxes, the state also imposes the 6 percent sales tax on motor fuels. The sales tax is levied on the retail price of motor fuels, including the federal motor fuel excise tax (18 cents per gallon), but not the state excise taxes. 5 OAG , No Tax rates current as of January 1, Source: Federation of Tax Administrators. 7

18 CRC Report Use Tax as Complement to Sales Tax The state use tax was enacted in 1937 as a complement to the sales tax. The use tax is levied on items that are purchased from out-of-state, or that are rented and leased and then used in Michigan. The use tax effectively prevents Michigan residents from avoiding taxation through these transactions. Since its inception, the use tax rate has mirrored the sales tax rate. If approved, Proposal 15-1 would trigger changes to the Use Tax Act to increase the tax rate from 6 percent to 7 percent to match the increase in the sales tax rate, effective October 1, Currently, to the taxpayer, the use tax is a single tax levied at 6 percent. However, the use tax, similar to the sales tax, has different components. Just like the sales tax, language added to the Constitution by Proposal A of 1994 requires the legislature to impose a 2 percent use tax and dedicates this funding to the School Aid Fund: this represents a rate floor. The rate ceiling is a key difference between the sales and use taxes. As noted, since 1954 there has been a rate cap on the sales tax; however, no such cap exists for the use tax. Because of this, the legislature has complete discretion to set the rate. There are two additional components making up the remaining 4 percent tax; these are contained in state law. The current 4 percent levy is divided between a state share that flows into the state s General Fund and a local share that is used to reimburse local governments for foregone property tax revenues. These statutory components were created as a result of personal property tax reforms enacted in The rate of the local share is determined annually to generate a specified amount of money needed to reimburse local governments. The rate of the state share is the residual amount; the difference between 4 percent and the local share tax rate. The state has levied the sales tax on motor fuels since the adoption of the tax in A number of other states also levy a sales tax on motor fuel as well as allow local governments to levy separate sales taxes on motor fuels. Constitutional Exemption. If approved, Proposal 15-1 will exempt certain motor fuels from the state sales tax. The specific language that will be added to Article IX, Section 8 states, No sales or use tax shall be charged or collected from and after October 1, 2015 on the sale or use of gasoline or diesel fuel used to operate a motor vehicle on the public roads or highways of this state. Other Fuels and Uses not Exempt. The language of the proposed constitutional amendment and implementing statute are specific as to the type of fuel to be exempted from taxation gasoline and diesel. Also, they specify the use of fuel eligible for the tax emption that used to operate motor vehicles on public roads. Because of the language s specificity, Proposal 15-1 does not exempt all gasoline and diesel fuel from the sales tax. Fuel sold to power boats, off-road vehicles, landscaping equipment (e.g., lawnmowers, blowers, etc.), and fuel used for other non-motor vehicle use would still be subject to the sales tax. Similarly, fuel sold to operate motor vehicles that are not used on public roadways could continue to be taxed under the General Sales Tax Act. Also, the sales tax would continue to be assessed on other fuels used to power motor vehicles, such as fleet vehicles that run on compressed natural gas (CNG). These other fuels and uses would be subject to the higher motor fuel taxes contemplated in the laws tiebarred to the passage of Proposal 15-1 (discussed later). Therefore, the higher motor fuel taxes applied to purchases of these fuels would not be offset by the elimination of the sales tax on these fuels. As a result, the pump price of these fuels would increase substantially and would be higher than other fuel. Also, it should be noted that the vast majority of gasoline and diesel fuel is sold by gas stations without regard to the intended use. The creation of the sales tax exemption for some fuel sales and not others may create compliance challenges for taxpayers. It should be noted that while Proposal 15-1 creates a sales tax exemption for certain motor fuels in the Michigan Constitution, nothing in the proposal would prevent the legislature, at a future date and by 8

19 Proposal 15-1: Sales and Motor Fuel Tax Increases Related to Transportation Funding separate legislation, from expanding statutory sales tax exemptions for fuel sold for other uses (e.g., landscaping, marine, etc.) or exempting from the sales tax other fuels used to power motor vehicles on public roads (e.g., CNG). However, if Proposal 15-1 is approved, the legislature would not be able to undo the constitutional sales tax exemption for motor fuel used to operate vehicles on the roadways by amending statutory law; it would take another constitutional amendment to undo or modify the exemption. In this way, the exemption would be more permanent than a statutory exemption. proposed increase in the maximum sales tax rate. This change will increase the amount of sales tax revenue going to local governments in the aggregate and increase the amount that each governmental unit receives under the per-capita formula. School Aid Fund. Currently, Article IX, Section 11 of the Michigan Constitution directs 60 percent of the sales tax imposed at a rate of 4 percent to the state School Aid Fund (SAF). In addition, 100 percent of both the sales and use taxes imposed at the 2 percent rate is dedicated to the SAF. The SAF provides the bulk of support for public school operations. Sales and Use Tax Revenue Earmarks Proposal 15-1 modifies two existing constitutional sales tax revenue earmarking provisions and creates a new use tax revenue earmark. Local Governments. Currently, Article IX, Section 10 provides that 15 percent of the sales tax imposed at the 4 percent rate be used exclusively for assistance to cities, villages, and townships on per-capita basis. The funding local governments receive under this provision is commonly referred to as constitutional state revenue sharing, which is different from the state funds shared through various statutory provisions. Constitutional state revenue sharing dollars are unrestricted, meaning that local governments are free to use them as they wish. Dedicating a portion of the state sales tax revenues to local governments for their unrestricted use first occurred in 1946 as a result of the sales tax diversion amendment approved by voters. The current allocation was established in 1974, when voters increased the percentage of the sales tax directed to local governments from 12.5 percent to 15 percent as a tradeoff for exempting food and prescription drugs from the sales tax base. In 1994, voters amended this section again, primarily to specify that the local government allocation applied only to the sales tax at the 4 percent rate; the additional 2 percent rate added at the time is dedicated to the School Aid Fund. If approved, Proposal 15-1 will make one change in Section 10; replace 4.0% with 5.0% to reflect the The language opens the possibility for the legislature to provide 60 percent of the sales tax revenue at a rate less than 5 percent to the School Aid Fund. If approved, Proposal 15-1 will replace 4% with not more than 5% to reflect the proposed increase in the sales tax rate under Public Act 467 of This change has the potential to increase the amount of sales tax earmarked to the SAF. The intent of this wording change is fairly clear allow the SAF earmark to reflect the increase in the sales tax rate. Generally speaking, the addition of the words not more than is used in statutory construction to convey a ceiling, as opposed to a specific amount. Whereas the current constitutional language states that 60 percent of the sales tax at the 4 percent rate shall go to the SAF, the proposed language could limit the revenue allocation to the SAF. The language opens the possibility for the legislature to provide 60 percent of the sales tax revenue at a rate less than 5 percent. For example, if Proposal 15-1 is approved and the legislature sets the sales tax rate at the new constitutional maximum 7 percent, it could decide to allocate 60 percent of the revenue from the tax levied at 4 percent (current allocation) and direct 60 percent of the revenue from the remaining one percent tax to the state General Fund. (Note: Of the total 7 percent tax, 100 percent of the revenue from the tax levied at 2 percent is earmarked to the SAF.) The addition of the not more than wording would match the current sales tax earmark language to local governments (discussed above). While this wording change may open up an opportunity for the 9